Chapter 02 - Stock Investment - Investor Accounting and Reporting

Chapter 2 Test Bank

STOCK INVESTMENTS-INVESTOR ACCOUNTING AND REPORTING

Multiple Choice Questions LO1 1

When Eag When Eagle le Com Comp pan any y has has less less th than 50% 50% of of the the vot votin ing g sto stock of of Fish Corporation which of the following applies? a. Only the fair fair value value method method may be be used. used. b. Only the equity method may be used. used. c. Eit Either her the the fair value value method method or the equity equity method method may be used. d. Nei Neithe ther r the fair value value method method or the equity equity method method may be used.

LO1 2

Whic Wh ich h one one of th the e foll follow owin ing g item items, s, orig origin inal ally ly rec recor orde ded d in th the e Investment in Falcon Co. account under the equity method, would not be systematically charged to income on a periodic basis? a. Amortizat Amortization ion expen expense se of goodw goodwill. ill. b. Depreciation expense expense on the excess excess fair value attributed attributed to machinery. c. Amor Amortizat tization ion expense expense on the the excess fair fair value attribu attributed ted to lease agreements. d. In Inte tere rest st ex expe pens nse e on th the e ex exce cess ss fa fair ir va valu lue e at attr trib ibut uted ed to long-term bonds payable.

LO2 3

Which one of the investor company?

following

statements

is

correct

fo r

an

a. Once Once the the balan balance ce in th the e Investment in Osprey Co. account reaches zero, it will not be reduced any further. b. Under the equity method, the balance in the Investment in Ospr Osprey ey Co. Co. acc cco oun unt t ca can n be ne nega gat tiv ive e if th the e in inv ves est tee corporation operates at a loss. c. App Applic licati ation on of the equity equity method method is discont discontinu inued ed when the investor’s share of losses reduces the carrying amount of the investment to zero. d. Unde Under r the equity equity method, method, any goodwill goodwill inherent inherent or contai contained ned Investment t in Osprey Osprey Co. account will be amortized in the Investmen to the income earned from the investee.

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LO2 4

Kestral Inc. owns 10% of Mouse Company. In the most recent year, Mouse had net earnings of $60,000 and paid dividends of $8,000. $8,00 0. Kestral’s Kest ral’s accoun accountant tant mi mistake stakenly nly assumed assumed co conside nsiderable rable infl in flue uenc nce e an and d us used ed th the e eq equi uity ty me meth thod od in inst stea ead d of th the e co cost st method. What is the impact on the investment account and net earnings, respectively? a. By using the the equity method method, , the accountan accountant t has understat understated ed the investment account and overstated the net earnings. b. By using the equity method, the accountant has overstated the investment account and understated the net earnings. c. By using the the equity method method, , the accountan accountant t has understat understated ed the investment account and understated the net earnings. d. By using the equity equity method, method, the account accountant ant has oversta overstated ted the investment account and overstated the net earnings.

LO2 5

Griffo Grif fon n In Inco corp rpor orat ated ed hol holds ds a 30 30% % ow owne ners rshi hip p in Duc Duck k Co Corp rpor orat atio ion. n. Grif Gr iffo fon n sh shou ould ld us use e th the e eq equi uity ty me meth thod od un unde der r wh whic ich h of th the e following circumstances? a. Griffo Griffon n has surrende surrendered red signific significant ant stockhol stockholder der rig rights hts by agreement between Griffon and Duck. b. Griffon has been unable to secure a position on the Duck Corporation Board of Directors. c. Grif Griffon’s fon’s owner ownership ship is tempo temporary rary. . d. The owners ownership hip of Duck Duck Corpora Corporation tion is is diverse. diverse.

LO2 6

Swan Sw an Corp Corpor orat atio ion n uses uses the fai fair r value value meth method od of acc accou ount ntin ing g for its inv invest estmen ment t in Pon Pond d Com Compan pany. y. Whi Which ch one of the fol follow lowing ing events would affect the Investment in Pond Co. account? a. b. c. d.

Invest Inve stee ee lo loss sses es Investee dividend dividend payments An incr increase ease in the investe investee’s e’s share share price from from last period. period. all al l of the above above woul would d aff affec ect t the Investment in Pond Co. account











LO3 7

Mudfla Mudf lat t Cor Corpo pora rati tion on’s ’s sto stock ckho hold lder er’s ’s equi equity ty at at De Dece cemb mber er 31, 31, 2004 2004 included the following: 8% Preferred stock, $10 par value Common stock, no par Additional paid-in paid-in capital Retained earnings

$

$

2,000,000 20,000,000 8,000,000 8,000,000 38,000,000

Brolga Corporation purchased a 30% interest in Mudflat’s common stock from other shareholders on January 1, 2005 for $11,600,000. What was the book value of Brolga’s investment in Mudflat? a. b. c. d. LO3 8

$10,80 $10, 800, 0,00 000 0 $11,400,000 $14, $1 4,24 240, 0,00 000 0 $14, $1 4,88 880, 0,00 000 0

Jabi Ja bir ru Co Cor rpo por rat ati ion purc purch has ased ed a 20 20% % int nte ere res st in Fish Fish Comp Compa any common stock on January 1, 2002 for $300,000. This investment was accounted for using the complete equity method and the correct balance in the Investment in Fish account on December 31, 2004 was $440,000. The original excess purchase transaction included $60,000 for a patent amortized at a rate of $6,000 per year. In 2005, Fish Corporation had net income of $4,000 per month earned uniformly throughout the year and paid $20,000 of dividends in May. If Jabiru sold one-half one-half of its its investm investment ent in Fish Fi sh on Au Aug gus ust t 1, 200 005 5 for $5 $50 00, 0,0 000 00, , how mu much ch ga gai in was recognized on this transaction? a. b. c. d.

$27 278 8,9 ,95 50 $280,000 $28 280 0,9 ,95 50 $28 282 2,0 ,00 00











LO3 9

An investor uses the cost method of accounting for its inve in vest stme ment nt in co comm mmon on st stoc ock. k. Du Duri ring ng th the e cu curr rren ent t ye year ar, , th the e investor received $25,000 in dividends, an amount that exceeded the inve investor’ stor’s s shar share e of the inves investee tee company’s company’s undis undistrib tributed uted income since the investment was acquired. The investor should report dividend income of what amount? a. $25 25, ,00 000 0. b. $25,000 less the amount in excess of its share of undistributed income since the investment was acquired. c. $25, $25,000 000 less less the amount amount that is not not in excess excess of its share share of undistributed income since the investment was acquired. d. Non None e of the the abov above e is corr correct ect. .

Use the following information in answering questions 10 and 11. On January 1, 2005, Coot Company acquired a 15% interest in Roost Corporation for $120,000 when Roost’s stockholder’s equity consisted of $600,000 capital stock and $200,000 retained earnings. Book values of Roost’s net assets equaled their fair values on this date. Roost’s net income and dividends for 2005 through 2007 was as follows:

Net income Dividends paid

LO3 10

$

2006 15,000 10,000

$

2007 25,000 10,000

Assume that Coot Incorporated used the cost method of accoun acc ountin ting g for its invest investmen ment t in Roo Roost. st. The bal balanc ance e in the Investment in Roost account at December 31, 2007 was a. b. c. d.

LO3 11

$

2005 12,000 10,000

$11 118 8,0 ,00 00. $120,000. $12 121 1,8 ,80 00. $13 130 0,8 ,80 00.

Assume Assu me tha that t Coot Coot has has sig signi nifi fica cant nt inf influ luen ence ce and and use uses s the the equi equity ty method of accounting for its investment in Roost. The balance in the Investment in Roost account at December 31, 2007 was a. b. c. d.

$11 118 8,0 ,00 00. $120,000. $12 121 1,8 ,80 00. $12 123 3,3 ,30 00.











LO3 12

Swamph Swam phen en Corp Corpor orat atio ion n accou account nts s for it its s 30% in inve vest stme ment nt in Fr Frog og Company using the equity method. On the date of the original investment, fair values were equal to the book values except for a patent, which cost Swamphen an additional $40,000. The patent had an estimated life of 10 years. years. Frog has a steady net income of $20,000 per year and its dividend payout ratio is 40%. Which one of the following statements is correct? a. The net will be b. The net will be c. The net will be d. The net will be

LO4 13

account account for for each full full year account for each each full year account account for for each full full year account account for for each full full year

Jacana Jaca na Cor Corpo pora rati tion on pai paid d $200 $200,0 ,000 00 for for a 25% 25% int inter eres est t in Lil Lilyp ypad ad Corporation’s common stock on January 1, 2005, but was not able to exer exercise cise significant significant influ influence ence over Lilyp Lilypad. ad. During 2006, Jacana reported income of $120,000, excluding its income from Lilypad, and paid dividends of $50,000. Lilypad reported net income of $40,000 during 2006 and paid dividends of $20,000. Jacana should report net income for 2006 in the amount of a. b. c. d.

LO4 14

chang change e in the investm investment ent a debit of $400. change in the investment a debit of $3,600. chang change e in the investm investment ent a credit credit of $400. chang change e in the investm investment ent a credit credit of $3,600.

$11 115 5,0 ,00 00. $120,000. $12 125 5,0 ,00 00. $13 130 0,0 ,00 00.

Robin Robi n Corpo Corpora rati tion on purc purcha hase sed d 150,0 150,000 00 prev previo ious usly ly unis unissu sued ed shar shares es of Nest Company’s $10 par value common stock directly from Nest for $3,400,000. Nest’s stockholder’s equity immediately before the inv invest estmen ment t by Rob Robin in con consis sisted ted of $3, $3,000 000,00 ,000 0 of cap capita ital l stock sto ck and $2, $2,600 600,00 ,000 0 in ret retain ained ed ear earnin nings. gs. Wha What t is the boo book k value of Robin’s investment in Nest? a. b. c. d.

$1,500 $1,5 00,0 ,000 00. . $1,680,000. $2,8 $2 ,800 00,0 ,000 00. . $3,0 $3 ,000 00,0 ,000 00. .











LO4 15

The inco The income me fro from m an equi equity ty inv inves este tee e is repo report rted ed on on one one line line of of the investor company’s income statement except when a. the cos cost t metho method d is use used. d. b. the investee has extraordinary or other “below the line” items. c. the investor company is amortizing cost-book value differentials. d. the invest investor or company company change changes s from the cost cost to the equity equity method.

LO5 16

Bart Com Bart Compa pany ny pur purch chas ased ed a 30% 30% int inter eres est t in Sim Simps pson on Cor Corpo pora rati tion on on on Janu Ja nuar ary y 1, 20 2004 04, , an and d Ba Bart rt ac acco coun unte ted d fo for r it its s in inve vest stme ment nt in Simp Si mpso son n un unde der r th the e eq equi uity ty me meth thod od fo for r th the e ne next xt 3 ye year ars. s. On January 1, 2007, Bart sold one-half of its interest in Simpson after which it could no longer exercise significant influence over Simpson. Bart should a. cont contin inue ue to ac acco coun unt t fo for r it its s re rema main inin ing g in inve vest stme ment nt in Da Dak k under the equity method for the sake of consistency. b. adjust the investment investment in Simpson account to one-half one-half of its original amount and account for the remaining 15% interest using the equity method. c. acco account unt for the remaini remaining ng inves investmen tment t under the the cost method, method, using the investment in Simpson account balance immediately after the sale as the new cost basis. d. adj adjust ust the investm investment ent account account to one one-ha -half lf of its origina original l amou am ount nt (o (one ne-h -hal alf f of th the e pu purc rcha hase se pr pric ice e in 20 2004 04), ), an and d accoun acc ount t for the rem remain aining ing 15% inv invest estmen ment t und under er the cos cost t method.

LO5 17

Pelican Corporation acquired a 30% interest in Crustacean Incorp Inco rpor orat ated ed at bo book ok va valu lue e seve severa ral l ye year ars s ag ago. o. Cr Crus usta tace cean an declared $100,000 dividends in 2005 and reported its income for the year as follows: Income from continuing operations Loss on discontinued division Net income Investment t Pelican’s Investmen increase by

in

Crustacean Crustacean

$700,000 (100,000) $600,000 accoun acc ount t

for

2003 200 3

should sho uld













LO5 18

Cormorant Corporation paid $800,000 for a 40% interest in Plumage Company on January 1, 2005 when Plumage’s stockholder’s equity was as follows: 10% cumulative preferred stock, $100 par Common stock, $10 par value Other paid-in capital Retained earnings Total stockholders’ equity

$

500,000 300,000 400,000 800,000 $2,000,000

On th thi is dat ate e, the boo book val alu ues of Plu lum mag age’ e’s s as asse set ts an and d liab li abil ilit itie ies s eq equa uale led d th thei eir r fa fair ir va valu lues es an and d th ther ere e we were re no dividends in arrears. Goodwill from the investment is a. b. c. d. LO5 19

$0. $150,000. $20 200 0,0 ,00 00. None Non e of the the abov above e is corr correct ect. .

In refe refere renc nce e to mate materi rial al tran transa sact ctio ions ns betw betwee een n an in inve vest stor or and and an investee, when the investor can significantly influence the inve in vest stee ee, , wh whic ich h of th the e fo foll llow owin ing g st stat atem emen ents ts is co corr rrec ect, t, assuming that the investor is using the equity method? a. There There is the presumptio presumption n of arms-leng arms-length th bargainin bargaining g between between the related parties. b. As long as the investor recognizes the effects of the transaction in its financial statements, it is not required to provide any additional disclosures. c. In re repo por rti tin ng it its s sh shar are e of ea earn rni ing ngs s an and d lo los sse ses s of an investee, the investor must eliminate the effect of profits and losses on the transactions until they are realized. d. Non None e of the the abov above e is corr correct ect. .











LO6 21

Firms must conduct annually when

impairment

tests

more

frequently

than

a. other other sharehold shareholders ers hold hold more more than 50% interes interest t b. a more-likely-than-not more-likely-than-not expectations expectations exists that a unit will will be sold or disposed disposed of c. a specific specific unit unit does not not have publicl publicly y traded traded stock d. usi using ng the the equi equity ty meth method. od.











Exercises LO3 Exercise 1

Crake Corporation paid $50,000 for a 10% interest in Lagoon Corp. on Januar Jan uary y 1, 200 2004, 4, whe when n Lag Lagoon oon’s ’s sto stockh ckhold olders ers’ ’ equ equity ity con consis sisted ted of $400 $4 00,0 ,000 00 of $1 $10 0 pa par r va valu lue e co comm mmon on st stoc ock k an and d $1 $100 00,0 ,000 00 re reta tain ined ed earnings. On December December 31, 2005, Crake Crake paid $96,000 for for an additional 20% interest in Lagoon Corp. Both of Crake’s investments were made when Lagoon’s book values equaled their fair values. Lagoon’s net income and dividends for 2004 and 2005 were as follows:

Net income Dividends

2004 $30,000 $10,000

2005 $70,000 $20,000

Required: 1. Prepar Prepare e jou journa rnal l ent entrie ries s for Bender Bender Cor Corpor porati ation on to acc accoun ount t for its investment in Andy Corporation for 2004 and 2005. 2. Calculate Calculate the balance balance of Bender’s Bender’s investme investment nt in Andy at December December 31, 2005.











LO3 Exercise 2

Wader’s Corporation Corporation paid $120,000 $120,000 for a 25% interest interest in Shell Company Company on July 1, 2005. No information is available on the fair value of Shell’s assets and liabilities. Assume the equity method. Shell’s trail balances were as follows:

Debits Current assets Noncurrent assets assets Expenses Dividends (paid in June) Total Credits Current Liabilities Capital stock (no change) Retained earnings Jan. 1 Sales Tot otal al

December 31 $ 100,000 300,000 160,000 40,000 $ 600,000

60,000 200,000 100,000 240,000 $ 60 600, 0,00 000 0

July 1 $ 50,000 310,000 120,000 40,000 $ 520,000

$

$

$

40,000 200,000 100,000 180,000 520 20, ,00 000 0

Required: 1. What is Wader’s Wader’s investm investment ent income income from Shell Shell for the year year ending December 31, 2005? 2. Calcul Calculate ate Wader’s Wader’s investm investment ent in She Shell ll at yea year r end Decembe December r 31, 2005.











Exercise 3 Dotterel Corporation paid $200,000 cash for 40% of the voting common stock of Swamp Land Inc. on January 1, 2005. Book value and fair value information for Swamp on this date is as follows:

Assets Cash Accounts receivable Inventories Equipment

Liabilities & Equities Accounts payable Note payable Capital stock Retained earnings

Book Values $ 60,000 120,000 80,000 340,000 $ 60 600,000

Fair Values $ 60,000 120,000 100,000 400,000 $ 68 680,000

$ 200,000 120,000 200,000 80,000 $ 60 600,000

$ 200,000 100,000

$ 30 300,000

Required: Prepare an allocation schedule for Dotterel’s investment in Swamp Land.













LO5 Exercise 4 Sand Sandpi pipe per r Inc. Inc. acqu acquir ired ed a 30% 30% inte intere rest st in Shor Shore e Corp Corpor orat atio ion n for for $27,000 $27,000 cash on January January 1, 2005, when Shore’s Shore’s stockholders’ stockholders’ equity cons consis iste ted d of $30, $30,00 000 0 of capi capita tal l stoc stock k and and $20, $20,00 000 0 of reta retain ined ed earnings. Shore Corporation reported net income of $18,000 for 2005. The allocation of the $12,000 excess of cost over book value acquired on January 1 is shown below, along with information relating to the useful lives of the items: Overvalued receivables (collected in 2005) Undervalued inventories (sold in 2005) Underv Undervalu alued ed buildi building ng (6 years’ years’ useful useful life life remaining at January 1, 2005) Undervalued land Unrecorded patent (8 years’ economic life remaining at January 1, 2005) Undervalued accounts payable (paid in 2005) Tota Total l of exce excess ss allo alloca cate ted d to iden identi tifi fiab able le assets and liabilities Goodwill Excess cost over book value acquired

$

(

600 ) 2,400 3,600 900 3,200

(

$

300 )

7,200 2,800 12,000











LO5 Exercise 5

Stilt Corpo Stilt Corporatio ration n purc purchased hased a 40% interest interest in the common stock of Shallo Sha llow w Com Compan pany y for $2, $2,660 660,00 ,000 0 on Jan Januar uary y 1, 200 2005, 5, whe when n the boo book k value of Shallow’s net equity was $6,000,000. Shallow’s book values equaled their fair values except for the following items:

Inventories Land Building-net Equipment-net

$

Book Value 450,000 100,000 400,000 350,000

$

Fair Value 500,000 450,000 200,000 400,000

Difference $ 50,000 350,000 ( 200,000 ) 50,000

Required: Prepare a schedule to allocate any excess purchase cost to identifiable assets and goodwill.

LO5











LO5 Exercise 7 Lowt Lowtid ide e Corp Corpor orat atio ion n had had $300 $300,0 ,000 00 of $10 $10 par par valu value e comm common on stoc stock k outstanding on January 1, 2004, and retained earnings of $100,000 on the the same same date date. . Duri During ng 2004 2004, , 2005 2005, , and and 2006 2006, , Lowt Lowtid ide e earn earned ed net net income incomes s of $40,00 $40,000, 0, $70,00 $70,000, 0, and $30,00 $30,000, 0, respec respectiv tively ely, , and paid paid dividends of $30,000, $55,000, and $10,000, respectively. On Januar January y 1, 2004, 2004, Avocet Avocet purcha purchased sed 21% of Lowtid Lowtide’s e’s outsta outstandi nding ng common stock for $124,000. On January 1, 2005, Avocet purchased 9% of Lowtid Lowtide’s e’s outsta outstandi nding ng stock stock for $51,00 $51,000, 0, and on Januar January y 1, 2006, 2006, Avoc Avocet et purc purcha hase sed d anot anothe her r 5% of Lowt Lowtid ide’ e’s s outs outsta tand ndin ing g stoc stock k for for $32, $32,00 000. 0. All All paym paymen ents ts made made by Avoc Avocet et that that are are in exce excess ss of the the appropriate book values were attributed to equipment, with each block depreciable over 10 years under the straight-line method. Required: 1. How much deprec depreciatio iation n expense expense will Avocet Avocet record record in 2004, 2005, 2005, and 2006? 2. What What will be the Decem December ber 31, 31, 2006 balanc balance e in the Investment Lowtide account after all adjustments have been made?

in











LO5 Exercise 8

For 200 2003, 3, 200 2004, 4, and 2005, Squ Squid id Cor Corpor porati ation on ear earned ned net inc income omes s of $40,000, $70,000, and $100,000, respectively, and paid dividends of $24,00 $24 ,000, 0, $32 $32,00 ,000, 0, and $44 $44,00 ,000, 0, res respec pectiv tively ely. . At the beg beginn inning ing of 2003, Squid had $500,000 of $10 par value common stock outstanding and $100,000 of retained earnings. On January 1 of each of these years, Albatross Corporation bought 5% of the outstanding common stock of Squid paying $37,000 per 5% block on January 1, 2003, 2004, and 2005. All payments made by Albatross in exce ex cess ss of bo book ok va valu lue e we were re at attr trib ibut utab able le to eq equi uipm pmen ent, t, wh whic ich h is depreciated over five years on a straight-line basis. Required: 1. Assumi Assuming ng that Albatros Albatross s use uses s the cost method method of acc accoun ountin ting g for its investment in Albatross, how much dividend income will Tripp reco re cogn gniz ize e fo for r ea each ch of th the e th thre ree e ye year ars s an and d wh what at wi will ll be th the e balance in the investment investment account at the end of each each year? 2. Assumi Assuming ng tha that t Alb Albatr atross oss has sig signif nifica icant nt inf influe luence nce and use uses s the equi eq uit ty met eth hod of acc cco oun unti tin ng (eve (e ven n thou th oug gh its it s own wne ers rshi hip p percentage is less than 20%), how much net investee income will Albatross recognize recognize for each of the the three years?











LO5 Exercise 10

On January 1, 2005, Shearwater, Co. purchased 60% of the outstanding voting common stock of Colony, Inc., for $1,800,000. The book value of Colony’s net equity on that date was $3,000,000. Book values were equal to fair values except as follows:

Assets & Liabilities Liabilities Inventory Building Note payable

Book Values $ 200,000 850,000 300,000

Fair Values $ 225,000 750,000 320,000

Required: Prepare a schedule to allocate any excess purchase cost to specific assets and liabilities.













SOLUTIONS Multiple Choice Questions 1

C

2

A

3

C

4

D

5

D

6

C











11

D

12

C

13

C

14

D

Initial Investment in Roost adjustments: 2003: 15% x ($12,000-$10,000)= 2004: 15% x ($15,000-$10,000)= 2005: 15% x ($25,000-$10,000)= Investment balance at 12/31/2005:

Jacana’s separate income Dividend income from Lilypad equals $20,000 x 25% = Jacana’s net income = Shares outstanding before new

$

120,000

$

300 750 2,250 123,300

$

120,000

$

5,000 125,000











18

C

19

C

20

B

Cost of Cormorant’s investment: Less: book value acquired: Total equity $ Less: Preferred equity Net common equity x percent acquired = Plumage book value Goodwill

$

800,000

$

600,000 200,000

2,000,000 500,000 1,500,000 40% 600,000











Exercise 2 Requirement 1 Sales (increase in trial balance) Less: Expense (increase in trial balance)

$

60,000 (

Net Income = Wader’s ownership of 25% 25%

$ yields 5,000 investment income

Requirement 2

Debit Initial Investment

120,000

Credit

40,000) 20 2 0,000











Exercise 4 Sandpiper’s share of Shore net income ($18,000 x 30%) Add: Overvalued accounts receivable collected in 2005 Add: Undervalued accounts payable paid in 2005 Less: Undervalued inventories sold in 2005 Less: Depreciation on building undervaluation $3,600/6 Less: Amortization on patent $3,200/8 years

$

Income from Shore

$

Exercise 5

( ( (

5,400 600 300 2,400) 600) 400) 2,900













Exercise 6

Cost of Curlew’s 20% investment in Waterway Less: Value of net assets acquired: 20% x $400,000 of net assets =

$

50,000 40,000











Exercise 7 Calculation of Lowtide’s net assets at the end of each year: Lowtide’s net assets on January 1, 2004 $ Plus: 20 2001 ne net in income mi minus di dividends ($ ($40,000–$30,000)

400,000 10,000











Exercise 8 Calculation of Squid’ net assets at the end of each year: Squid net assets on January 1, 2003 $ Plus: 2003 net income minus dividends ($40,000–$24,000)

600,000 16,000











Requirement 2: 2003 net income from Squib (investee) = (5% x 40,000) – Depreciation of $1,400 ($7,000/5 years) =

$

(

600











Exercise 10 Cost of Bosco’s 60% investment in Elsie Less: Value of net assets acquired: 60% x 3,000,000 of net assets =

$

1,800,000 1,800,000

Chapter 02 - Stock Investment - Investor Accounting and Reporting

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